Wednesday, December 12, 2007

Fraud Without Loss in the Reyes Case

Former Brocade CEO Gregory Reyes got a dose of pretty good news from U.S. District Judge Charles Breyer about his upcoming sentencing for options backdating at the company.  In an opinion (available below) discussing various sentencing issues, Judge Breyer determined that the government did not propose any reasonable method for determining the loss from the backdating, and therefore he would not apply an enhancement under the Sentencing Guidelines for loss to increase the offense level.  The Judge did not find the loss was zero, which could be a more problematic conclusion, but instead found that the government's various proposed methods of calculating the loss were inadequate to fairly estimate the harm.  Complicating matters in this case, which may make it sui generis, is that Reyes did not personally profit from the backdating, at least not as charged in the indictment, so intended gain is not available.  The government argued that Reyes did profit from other the backdating of other options not charged in the case, but the court rejected that as not proven by the government.

One method proposed by the government was to look at the decline in Brocade's stock price on the day the company disclosed the improper accounting for the options, which triggered a loss of over $3 million.  Judge Breyer rejected that method, finding that it did not adequately measure any loss directly from the backdating but only how the market reacted on one particular day to a news event.  The Judge also rejected using a "recissory" method to estimate the value of the options as backdated because in fact they turned out to be worthless, due to the significant decline in Brocade's stock price when the tech bubble burst and all the options ended up under water.  Finally, he rejected using the amount of the SEC fine Brocade paid, which was $7 million, and the tax liability it assumed for covering the tax consequences of the backdating, which was over $3 million.  On the SEC fine, the court stated that this method had never been used before, and for such a significant enhancement he would not adopt a novel method of calculating the loss.  The amount of the loss is the primary driver of sentences under the Guidelines, and by finding no loss from the backdating, Reyes avoided a sentence that could have stretched past twenty years if a particularly high figure was calculated. 

Judge Breyer did enhance the sentence on two grounds: Reyes' role as an officer of a public company and as an organizer of the criminal conduct.  Together with the base offense level, the Guidelines sentencing range is 15-21 months, based on an Offense Level of 14.  Not a walk in the park for Reyes, for sure, but substantially less than what has been seen in other CEO prosecutions.

After the Supreme Court's recent decisions in Gall and Kimbrough granting district judges considerably more discretion in sentencing, I suspect Judge Breyer may depart from the Guidelines recommendation.  It would not surprise me if he gave Reyes a split sentence, perhaps the old "double nickel" of five months in prison and five of home confinement, and could even give a pure home confinement/probation sentence.  Prior to Gall, I would have expected prosecutors to appeal the district court's loss analysis.  But now that the standard of review is abuse-of-discretion, I doubt the Judge's analysis is so off base as to draw a reversal from the Ninth Circuit.  Reyes is sure to appeal the conviction, but I think the sentencing will be good news, at least to the extent one can ever say that being sentenced in federal court provides a measure of good news.

The court's loss determination is definitely good news for Stephanie Jensen, Brocade's former human resources manager who was also convicted in a separate trial on conspiracy and false SEC filings charges for the Brocade backdating.  Given that she is unlikely to qualify for the organizer enhancement like Reyes, and probably was not in a senior position to trigger the four-level enhancement for being an officer of a public company, her offense level would be 6, leading to a sentencing range of 0-6  months.  At that level, she would be eligible for probation, or home confinement at worst, a far better outcome for her than a term of imprisonment. (ph)

Download us_v_reyes_sentencing_guidelines_loss_opinion_nov_27_2007.pdf

http://lawprofessors.typepad.com/whitecollarcrime_blog/2007/12/fraud-without-l.html

Fraud, Securities, Sentencing | Permalink

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Former Brocade Communications CEO Gregory Reyes received a 21-month prison term from U.S. District Judge Charles Breyer for his convictions related to backdating options grants at the company. I expected the Judge to impose a lower sentence, perhaps dr... [Read More]

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